TODAY’S S&P 500 SET-UP - October 20, 2010

As we look at today’s set up for the S&P 500, the range is 15 points or -0.93% downside to 1155 and 0.35% upside to 1170. Equity futures are trading above fair value and close to session peaks as markets recover some of their poise in the wake of yesterday's decline.


Earnings remain a key focus this morning, while the Beige Book will provide the main economic focus.

  • Cree (CREE) 2Q sales forecast missed est.
  • Intuitive Surgical (ISRG) 3Q rev. missed est.
  • Juniper Networks (JNPR) 4Q sales, adj. EPS may beat est. 
  • Stryker (SYK) 2010 EPS forecast exceeds est., raises FY EPS bottom end forecast
  • Western Digital (WDC) 1Q adj. EPS beat est.
  • Yahoo! (YHOO) forecast 4Q sales below est.


  • One day: Dow (1.48%), S&P (1.59%), Nasdaq (1.76%), Russell 2000 (2.25%)
  • Month/Quarter-to-date: Dow +1.77%, S&P +2.16%, Nasdaq +2.88%, Russell +2.66%
  • Year-to-date: Dow +5.28%, S&P +4.56%, Nasdaq +7.39%, Russell +10.99%
  • Sector Performance: Materials (2.56%), Energy (1.99%), , Healthcare (1.88%), Consumer Disc (1.81%), Tech (1.77%), Industrials (1.33%), Financials (1.39%), Consumer Spls (1.22%), Utilities 0.19%.


  • ADVANCE/DECLINE LINE: -1977 (-2961)
  • VOLUME: NYSE - 1271.64 (+27.65%)
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Massey Energy +4.98%, Capital One +4.11% and Parker Hannifin +3.67%/Supervalue -14.92%, Harley Davidson -6.74% and Urban Outfitters -6.12%.
  • VIX: 20.63 +8.41% - YTD PERFORMANCE: (-4.84%)
  • SPX PUT/CALL RATIO: 1.46 from 1.45 +0.86%


  • TED SPREAD: 15.66 -0.265 (-1.664%)
  • 3-MONTH T-BILL YIELD: 0.14% -0.01%  
  • YIELD CURVE: 2.13 from 2.14


  • CRB: 292.98 -1.93%
  • Oil: 79.49 -4.32% - BULLISH
  • COPPER: 375.75 -2.53% - OVERBOUGHT
  • GOLD: 1,341.00 -2.21% - BULLISH


  • EURO: 1.3812 -1.27% - BULLISH
  • DOLLAR: 77.752 +1.62%  - BEARISH



European markets:

  • FTSE 100: +0.33%; DAX +0.19%; CAC 40 +0.21%
  • Major indices have reversed opening losses to trade in the black helped by a recovery in financials and firmer metals prices which has helped drive mining shares higher.
  • BASF (BAS.GR) hiked its 2010 forecasts.
  • UK BoE minutes show MPC split on QE, Chancellor Osborne to give a statement on Spending Review.
  • German Govt forecasts growth of +3.4% in 2010 and +1.8% in 2011
  • Germany Sep PPI +3.9% y/y vs cons +3.8%

Asian markets:

  • Nikkei (1.65%); Hang Seng (0.87%); Shanghai Composite +0.07%
  • Regional markets closed lower, with metals and resources stocks leading declines on China’s interest-rate hike.
  • China reversed an initial 1.8% drop to close in positive territory, though property stocks showed substantial losses.
  • Blue chips traded lower in Japan, and China-related stocks fell significantly as all 33 sectors fell.
  • Gold miners fell in Australia on lower prices 
Howard Penney
Managing Director

THE DAILY OUTLOOK - outlook image













China's Team

“Leadership is getting someone to do what they don't want to do, to achieve what they want to achieve.”

-Tom Landry


Per our friends at Wikipedia, “the term America’s Team is a popular nickname in American sports that often refers to the Dallas Cowboys of the National Football League. The nickname originated with the team’s 1978 highlight film, where the narrator opens with the following introduction:”


“They appear on television so often that their faces are as familiar to the public as presidents and movie stars. They are the Dallas Cowboys, America's Team."


Tom Landry was the accountable leader and coach of America’s team. His teams won 2 Super Bowls, 5 NFC titles, and 13 Divisional titles and his 20 career playoff wins are still the most ever by an NFL coach. Ever, as we like to say at Hedgeye, is a very long time…


This year, America’s Team looks like it’s being coached by Ben Bernanke. The Dallas Cowboys have started the season at 1-4. Leadership is lacking and teams playing against them aren’t going to quantitatively ease what they want to achieve in spite of them.


Who is China’s Team? Who are their leaders playing for? Are they willing to do what they need to do to achieve what they want to achieve? Yesterday, China’s Team continued to do exactly what a politicized and feeble American leadership team has not, and will not, have the spine to do – respect the cost of capital and fight inflation.


China raised interest rates because they see what we see. It’s priced in copper, corn, and cows. Until yesterday, it was all staring every real-time risk manager in the face. Before yesterday’s -2% selloff, the CRB Commodities Index (a basket of 19 commodities) hit a fresh YTD high. The score is a stickler that way. It doesn’t lie; politicians do.


Yesterday morning, as Wall Street’s latest leadership lemming was talking about the “power of the franchise” at Bank of America while his stock was hitting a fresh 52-week low, I started laughing out loud in my office…


I wasn’t laughing because my Managing Director of Financials, Josh Steiner, has had me short BAC 9 times (profitably) since late 2009. I was laughing at Brian Moynihan like I would any coach or player who seriously has no idea how badly he is losing.


As the day progressed and the US stock market selloff picked up momentum, breaking a critical immediate term TRADE line of support (1170 on the SP500), it was hard to discern which factor was the driving force…

  1. Was it Apple?
  2. Was it Gold?
  3. Was it Bank of America?

Or was it fear that China’s Team was providing some leadership to this global economic system by doing something that US-centric stock market investors didn’t want them to do? China doesn’t want to hold the bag of inflation risk associated with Bernanke’s Quantitative Guessing.


Notwithstanding that the fear of raising interest rates is a narrative fallacy unique to CNBC watchers (Chinese stocks closed up overnight on news of their rate hike, fyi), this morning’s manic media in America will be right back at it beating the drum of losers.


In yesterday’s missive I wrote that America’s markets are turning into the sort of soft and qualitative excuse making zones where losers find comfort and coddling.


Read these two headlines this morning and you tell me – are we winners or losers?

  1. “Bank of America says it is not responsible for the poor performance of loans due to the bad economy” –CNBC
  2. “Dollar weakens on prospects of Fed officials to signal easing” –Bloomberg

Sadly, I think we have completely lost touch with what America’s Team should stand for. Whether it’s total abdication of responsibility from an Investment Banking Inc. CEO or a Blind Belief that Big Government Intervention is the only way out – it’s driving the winners in this country to trust China’s Team more than they trust their own.


Do you blame them? At the same time that Chinese, Brazilian, and Australian central bankers were proactively addressing inflation risk, the President of the Chicago Fed (Evans), who has never seen a commodity price go up that he’d call inflationary, was “reiterating his belief that the Fed should reassess how it measures inflation.” America, this is embarrassing. Flat out embarrassing.


After waiting and watching, we re-shorted America’s stock market team (SPY) last Wednesday, October 13th at 11:54AM EST. We shorted its conflicted and compromised currency (UUP) on Monday, June 7th at 3:38PM EST.


The losers in this country can call what my team does whatever they want – we call it being on the winning side of this leadership mess. We are Hedgeye Risk Management and we support this message.


My immediate term support and resistance lines for the SP500 are now 1155 and 1170, respectively. On weakness yesterday, we added another 3% to the long Germany (EWG) position in the Hedgeye Asset Allocation Model. Germany’s Team is winning too.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer

China's Team - china


The Macau Metro Monitor, October 20th 2010


In the first nine months of 2010, Macau’s total public revenue (not including autonomous agencies) rose by 37.3% to MOP55.82 billion (US$7 billion).  Direct taxes from gaming was up by 60.5% to MOP 46.56 billion.  A fiscal surplus of MOP31.91 billion was recorded in the first nine months of 2010, up by 56.7% as compared with the same period last year.


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As we wrote last week, we expect a sizeable Q3 beat out of PENN tomorrow. In preparation for the PENN Q3, we’ve put together the pertinent forward looking commentary from the Q2 earnings release/call and subsequent conferences.


Post Earnings Conference Commentary

  • We’ve got some properties doing exceptionally well, mostly surrounding table games, but other than that, I would say that the consumer is still struggling. And we don’t forecast for next year that, that’s going to change, well at least, we’re going to operate under the assumption that the consumer is going to continue to spend at the current levels of their spending at, and knock on wood, they don’t actually struggle anymore.”
  • “We are very happy with what’s happening with table games in West Virginia, and we know that these percentages will be coming down. So, next year, I don’t believe we’ll have any property north of 20% of our EBITDA.”
  • “Our table games went live in July, it’s been just a staggering success. We’ve been incredibly happy with the results in Charles Town.  Normally, we estimated our table games play to be a function of what our slots revenues were, and candidly, our best property before this was Lawrenceburg and Charles Town. I think Lawrenceburg was in the 15% range, and Charles Town has been averaging somewhere around 25%.”
  • “Penn National’s results have been very good.”
  • “We now own two of the racetracks in Ohio. It’s a bit of a hedge. We’re not exactly sure what’s going to happen with VLTs in Ohio. At this point, it doesn’t look like anything is going to happen before the election. And quite candidly, we think it’s going to be obviously a more focused discussion post-election time”
  • “Our view on Texas is, it is, we believe, very likely that gaming will come to Texas – I don’t know if it’s very likely, certainly north of 50%. And we want to be a part of it. And we wanted to be a part of it from -- in a way that gave us standing to participate in the process.”
  • “If gaming does come to Texas, it’s our belief that it will almost undoubtedly – if gaming comes, we’ll undoubtedly include gaming at the racetrack. That doesn’t mean that they won’t have other standalone facilities in the state, but we are convinced that if they do in fact come up with a measure in Texas for gaming, that tracks would be included.”
  • “It also gives us the ability to have standing in terms of being able to lobby in the State of Texas with credibility; that’s incredibly important.”
  • [Perryville] “Our margins are clearly going to be challenged somewhere in the low-to-mid-teens perhaps potentially we can do a little better for a while. But I think that’s probably closer to where we’re thinking.”
  • “Relative to guidance, nothing has changed.”


Q2 Conference Call:

  • “I guess I could characterize our business as, well, not wonderful but it’s stable and there are some bright spots that we will highlight further through our presentation.”
  • “We’re still seeing the same kind of consumer trends that we saw in prior quarters. It hasn’t gotten any better; it hasn’t gotten any worse. As you look at the unemployment levels around the markets we operate in and you look at the housing prices, I mean we’re still seeing softness on both of those macroeconomic fronts and it’s reflective in our consumer.”

Li-Ning: Picking up the Pace


“Discovering the enemy's dispositions and remaining invisible ourselves, we can keep our forces concentrated, while the enemy's must be divided.” – Sun Tzu



If U.S. based athletic footwear and apparel branded companies aren’t familiar with the ancient Chinese military general and author of The Art of War quoted above, we suggest they pick up a copy – perhaps then Li-Ning’s strategy wouldn’t be such a mystery. Since opening its design office in Nike’s back yard back in January 2008, China’s largest athletic footwear company has taken a methodical and understated approach to entering the U.S. athletic footwear/apparel market – this week’s launch of the company’s first lightweight running shoe is no different. Likely positive for retailers like FL, FINL, DKS and HIBB in the intermediate-term, potentially more competitive for NKE and UA long-term.


Given Li-Ning’s more public efforts over the past 2-months, we’ve taken a step back to put its development in context – consider the following:

  • Consistent with prior launches, partnerships, and corporate developments, Li-Ning officially launched the lightweight Freemont running shoe yesterday unbeknownst to just about everyone. While not the first foray into running (the F2 Runner launched in August), the Freemont confirms Li-Ning is both serious about entering the category and a legitimate innovator of technical footwear. The Freemont weighs ~7 ounces (nearly 15% lighter than Nike’s Free) and the F2 Runner features molded foam construction (think Crocs-like material, not look). We expect future launches to be similarly covert.
  • Li-Ning is no longer just a foreign-based basketball brand. With the addition of running, the company is quickly building out its product portfolio. There is talk of a lifestyle collaboration with NBA’er Baron Davis and along with other ‘off-the-court’ offerings.  Recall that Baron Davis is one of the higher profile endorsers of the brand beginning this season, along with rookie Evan Turner.  Similar to its approach in basketball, we anticipate additional high profile athlete endorsements in the coming months to promote new category extensions – stay tuned.
  • With an inherent low-cost structural advantage stemming from manufacturing assets and a low cost of capital, Li-Ning may actually have cost advantage on its domestic competition.  So far, product has been introduced at low-to-moderate price points. With basketball shoes selling from $65-$100 and the F2 Runner at $59.99, we wonder what happens if the company ups the ante with premium/technical offering at prices well below the current $100-$160 premium price point norms?  This point becomes more relevant as the brand does.
  • Few appreciate the size of Li-Ning and therefore, the backing behind these initiatives – the company reported sales of $1.3Bn USD in FY09 growing at a 2-year CAGR of ~40%. With roughly a 50/50 split between footwear and apparel revenues, the company’s footwear business is nearly 5x that of Under Armour by comparison. More importantly, besides having an R&D budget likely exceeding UA’s, the brand’s footwear heritage, team, and existing China infrastructure should enable it to test and adjust to underperforming initiatives rapidly.
  • Lastly, new product extensions are positive for domestic athletic footwear retailers. Given its existing exclusive relationship with FL’s Champ’s division in basketball (the Baron Davis line is exclusive), we expect Foot Locker to be a primary beneficiary of future develpments. It’s important to note, that the company is currently targeting specialty run shops for its new lightweight shoe. The key here remains how the brand ultimately decides to tier product by channel, with a clear differentiation between price points, technical features, and design. With it’s first foray into the market at sub-premium price points, we suspect price is being used a way to entice consumer trials.  Over time however, the jury is still out as to where the brand may sit on the shoe wall at any given retailer.

After studying its competition for more than 2-years now, Li-Ning is taking precise steps to enter select markets, which so far include basketball, running footwear, and compression apparel (they just acquired a high-end UA like compression company based in Australia) – for now. While the company has done a commendable job in staying largely ‘invisible’ to its competition, the accelerating product/event timeline below suggests the competitive threat on domestic soil is mounting.



Li-Ning: Freemont

Li-Ning: Picking up the Pace - LiNing Running 2 10 19 10


Li-Ning: F2 Runner

Li-Ning: Picking up the Pace - LiNing Running 1 10 19 10


Li-Ning: Picking up the Pace - LiNing USTimeline 10 19 10


Casey Flavin



Conclusion: Although DPZ posted strong results for 3Q10, the sustainability of the current trends and the company’s ability to better leverage top line growth are key issues going forward.


DPZ is trading well today, outperforming the restaurant space on the back of good earnings results from this morning.  While the results were strong, particularly on the top line, some questions arise going forward regarding the sustainability of their margin growth.   Recurring, diluted EPS growth for the quarter was 59% versus the third quarter of 2009.  Driving this growth was domestic company same-store sales growth of 11.8% and domestic franchise same-store sales growth of 11.7%.  On the negative side, gross margins declined by about 40 bps year over year.  This was the first compression in gross margins since 3Q08. 


The 10-Q provides some detail on the underlying dynamics of the margin compression.  In the section titled, “Domestic Company-Owned Stores Operating Margin”, it is stated that “as a percentage of store revenues, food costs increased 3.2 percentage points to 28% in the third quarter of 2010…due primarily to higher cheese and meat prices, a slight increase in the product costs for our improved pizza” and lower mix.   Insurance costs increased 1.9 percentage points to 5.4% as a percentage of store revenues.  On the conference call this morning, management mentioned insurance costs “as well as higher overall commodity cost” as being largely the cause of the margin decrease. 


While a minor point, by the way this was communicated; it seemed that management was implying that insurance costs were more of a factor than food.  In reality, food costs have increased far more on a year-over-year basis.   To that end, food costs have increased as a percentage of sales each quarter to date in 2010 where as the company had been able to leverage its insurance costs prior to 3Q10.  Management likely highlighted the higher insurance costs as they were less expected and potentially one-time in nature.  Higher commodity costs, however, were expected; though the YOY increase in food costs as a percentage of sales accelerated during the quarter to 320 bps from 190 bps and 150 bps in 1Q10 and 2Q10, respectively.  Although the company continued to get leverage on its labor and occupancy cost lines, it was disconcerting to see margins decline with comparable sales growth up 11.8%, particularly knowing that same-store sales growth will not be up double-digits forever.  Going forward, it will be interesting to see if DPZ can more successfully leverage its top line growth.  This will become especially important in 2011 when facing difficult same-store sales comps and facing commodity cost headwinds. 


DPZ will lap its first quarter of positive domestic company-owned same-store sales growth in 4Q10 (after eight quarters of declines).  The YOY impact on margin from higher cheese prices should decelerate in 4Q10, however, as cheese prices had already started to climb in 4Q09 with the average cheese block price per pound up about 24% from the 3Q09 level.  During 3Q10, the average cheese price increased nearly 29% YOY to $1.53 per pound, but if you assume prices hold relatively stable in 4Q10, cheese prices would only increase about 3% YOY, which should relieve some pressure on margins.  That being said, management also pointed to higher meat costs as an issue during the third quarter.






Howard Penney

Managing Director

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